John Kaiser: The bull is back

It used to be that retail investors attending investment shows like the recent Vancouver Resource Investment Conference would go out and actually buy the stocks their favourite speakers touted, says John Kaiser, the editor of Kaiser Research Online.

Kaiser, who calls it the “guru effect,” says that ended when it became obvious that accredited investors — individuals with at least $1 million in assets outside of real estate — were getting a manifestly better deal than retail investors.

“It became apparent that you guys are all here to be sold paper by existing shareholders,” Kaiser told an audience at the investment conference in January. “You were here to indirectly de-risk the whole process, and that’s BS.”

Accredited investors can participate in private-placement financings, which have become the lifeblood of the junior-mining industry. Such financings are priced as a discount to the market, and usually include warrants.

“You people have been forbidden from actually being venture capitalists,” Kaiser said. “You are just the aftermarket for paper issued to the elite, which does get to participate in private placements.”

But Kaiser believes the time of the retail investor is returning to the junior-mining sector.

Retail investors were turned off by the past decade’s focus on reworking the economics of existing projects in the context of higher metal prices, Kaiser notes. That focus was tailored to institutional investors and their knowledge of discounted cash-flow analysis and macroeconomic trends.

However, all the advanced projects, currently trading at low valuations, will soon be bought up by bottom-fishing mining companies, private equity firms and others with a three- to five-year time horizon — long enough for a recovery to take place.

“The game will not be in these advanced projects going forward. It has to go back to looking at projects for discoveries that work at the current metal prices, and work very well.”

It is the high-risk part of the sector focused on discoveries that creates the greatest returns, and as advanced projects disappear, this is what the sector will have to focus on.

“This is high-risk, high-reward speculation. This is not capital preservation,” Kaiser said. “This is an effort to expand capital by doing venture capital bets.”

With higher metal prices off the table for a few years, institutional investors are no longer interested in the sector. Accredited investors, too, are gone.

“Their favourite strategy was to do a private placement, wait the four months and then unload it onto the retail investor and clip the warrant — in other words, flip the stock, clip the warrant, de-risk their exposure and get a free ride on the fundamentals while you took the risk of whether or not the project worked out,” Kaiser said. “You guys are not there anymore eating this aftermarket paper, so the whole system, the whole model needs a rework.”

Kaiser noted that the regulators in Canada have come up with a proposal that would allow retail investors to participate in private placements (up to $15,000 per company, per year). The idea would make retail investors “part of this industry again, rather than the garbage can onto whom the sophisticated people dump their paper,” he said.

By allowing small-scale investors to put money into juniors’ treasuries, the idea also has the potential to “breathe life” back into the junior sector, which is in the midst of a capital crisis.

But after three years of “relentless decline” in the juniors, why would retail investors be interested in the sector?

Kaiser says the sector has bottomed: “We are not going to have a V-shaped recovery, but we are in the early stages of a selective bull market for individual juniors.

“When tax-loss selling ended around Dec. 31, at that point an inflection began. But you couldn’t really see it or feel it . . . on [Jan. 17] there was a quickening in the market, and that’s when I would say the bull has returned.”

Selectivity is key. Kaiser noted that 673 companies — or 38% of the companies he covers (1,800 resource companies listed on the TSX and TSX Venture Exchange in all) — have negative working capital. These are “zombie companies” investors should be careful to avoid.

There are 600 Venture-listed companies that are $1.5 billion in debt, collectively. These companies will have to issue a lot of paper to settle their debts, and may do more than one share consolidation over the next couple of years — which can be done without shareholder approval — as their share prices sink.

While those companies are to be avoided, there are still 434 TSX Venture-listed juniors that have between $500,000 and $20 million in working capital. These are the healthy companies investors should focus on, Kaiser says.

Just as the bottom is in for the junior mining sector, it’s also in for gold, he says.

After selling some 17.8 million oz. gold from ETFs last year, there are no more sellers left.

“What’s remaining is probably in secure hands,” Kaiser said. “That gold has flowed overseas to China or to cover the shorts that the banking system had out in gold. There is no more downside to be squeezed out of gold. The bottom is in.”

Despite the huge nominal rise in the gold price since it settled at US$400 per oz. in 1980 — after run-up to US$850 — in real terms gold has only risen by 14%, Kaiser noted.

“We have actually gone full circle,” he said. “Even though we have US$1,250 gold, it is a wash, we are back to square one.”

There is one “profound” difference, however. All of the deposits that are easier to find and develop are gone.

That means that at the current gold price, it would be impossible to match the past 30 years’ gold production of 2.3 billion oz. over the next three decades.

In an uncertain world where the U.S. is in relative decline, demand for gold will not fade away.

Perhaps more importantly, Kaiser sees gold as a measure of global wealth and twinned with the business cycle, rather than inverse to it.

In 1980, when gold reached a peak of US$850 per oz., the above-ground gold stock of 3 billion oz. represented 26% of global gross domestic product (GDP). Currently, there are 5.4 billion oz. gold, representing only 8% of GDP.

If we assume a 10% permanent relationship between the gold stock and global GDP, and assume current gold production continues at the same levels, Kaiser says, gold could remain stable at $1,200­ to $1,500 per oz. for the next few years.

The big gold buyers have been the emerging nations, especially China. China has not reported its gold holdings since 2009, when it held 34 million oz. Now the world’s largest gold producer, it has produced 45 million oz. since then — all of which was likely bought by its central bank. (For comparison, the U.S. has 216 million oz.)

When China next reports its gold holdings at much higher levels, Kaiser says it will spur even more buying, which will push gold up toward US$2,000 per oz.

— This article originally appeared on www.miningmarkets.ca .